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The Reserve Bank Australia is conducting expansionary monetary policy in an attempt to stimulate the Australian...

  1. The Reserve Bank Australia is conducting expansionary monetary policy in an attempt to stimulate the Australian economy. Using the loanable funds model, explain to your senior manager how the expansionary monetary policy can be implemented using open market operations and its impact on the supply of and demand for loanable funds, and the interest rate in Australia.
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Answer #1

An expansionary monetary policy is implemented by open market purchase of securities. This generates more reserves in the system, available for lending. Higher credit lending increases money supply.

Also, increase in reserves increases the supply of loanable funds, shifting its supply curve rightward, which decreases interest rate and increases the quantity of loanable funds.

In following graph, D0 and S0 are initial demand and supply curves for loanable funds, intersecting at point A with initial interest rate r0 and quantity of loanable funds Q0. An increase in supply shifts S0 rightward to S1, intersecting D0 at point B with lower interest rate r1 and higher quantity of loanable funds Q1.

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